ICG Commodity Update – November 2022

The ICG Commodity Update is our monthly published comment on the energy, industrial metals and precious metals market.

 

Energy

Markets have experienced intense headline volatility the last few sessions in advance of the OPEC meeting this weekend. Signs of an oversupplied market in recent weeks briefly pushed oil prices to lows not seen since last year, leading to speculation that the production cartel could cut output further to tighten supplies. Many forecasters expected that cut would spur a period of sustained oil price strength given a significantly bullish backdrop. In particular, analysts have pointed to sanctions on Russian oil production, weakening US production growth, and persistent global demand growth, with Morgan Stanley and Goldman Sachs expecting oil prices of >$100/bl by 1Q 2023. However, last week, the G7 implemented a Russian oil price cap at $67-$70/bl (i.e. above the current Russian oil price). As such, that has eased the pressure on global market participants that were expecting a more aggressive price cap, and a related reduction in Russian oil flows. On the other side, there are growing expectations/rumours that China is seeking to shift away from “Zero Covid” measures, towards a more relaxed policy/re-opening (albeit gradually). This is important as a substantial proportion of Chinese oil demand is used in the transportation sector (i.e. over 55% of Chinese oil demand, particularly consumption of diesel in trains and delivery trucks). Interestingly, the US moved to grant Chevron a license to resume oil production in Venezuela after sanctions halted all drilling activities almost 3 years ago. The increase in oil supply in the short term is limited (~ 0.2mb/d over a 6-12 months according to Credit Suisse) but is a change in narrative around US sanctions on Venezuela. No new investments are expected by the company in the country until certain debts are repaid by PDVSA to Chevron. Oil and Gas equities have outperformed the commodity recently and this resulted in some multiples expanding. Nevertheless, they don’t screen poorly in our eyes. According to analysts they continue to price-in high $60/bl WTI and low $3/mcf. Another perspective is the following: We launched the Energy Champions Fund in March 2014 with a NAV of $100/share and oil prices were around $100/bl. At that time the EV/EBITDA was at 5.5x, dividend yield at 2.6%, ROE at 13.3% and cash costs at $22/boe. Today we have an oil price of around $85/bl and the NAV is still at $68/share with an EV/EBITDA of 3.1x, dividend yield of 5.7%, ROE 34.6% and cash costs of $13/boe.

 

Industrial Metals

Commodities surged last month, with bullish investors emboldened by signs that China will take a softer line on Covid and the Federal Reserve will slow rate hikes. China’s top official in charge of its Covid response said the fight with the virus is entering a new stage, in remarks that hinted at more easing of stringent curbs. In Washington, the Fed signaled a slower pace of monetary tightening from December on. Both developments offer hope that two of this year’s major headwinds for industrial commodities may be at a pivot point. When it comes to copper, the warnings keep getting louder: the world is hurtling toward a desperate shortage of the metal. Humans are more dependent than ever on a metal we’ve used for 10,000 years. New discoveries in copper are increasingly unlikely, given the long history of mining – that means most of the world’s great deposits have already been found and exploited, more than half the world’s 20 biggest copper mines were discovered more than a century ago. Mines globally continue to grapple with logistical challenges exposed by the pandemic and exacerbated by Russia’s invasion and Chinese lockdowns. In the case of Chile, the top copper-producing nation, just registered its first year-on-year output increase since mid-2021, a sign the industry may be recovering from a string of operational disappointments – a rare sign of supply relief, although ore quality has been falling and some mines face water restrictions in a prolonged drought. On the company side, Rio Tinto announced it plans to spend up to $3 billion in each of the next three years to develop new capacity for commodities needed in the global economy’s energy transition. The investments will target commodities like copper and lithium, where demand is expected to grow rapidly in the coming decade, as well as iron ore, which is facing sweeping market changes as the steel industry tries to cut carbon emissions. The top global miners are all trying to embrace new sources of demand thrown up by decarbonization. Rio said it expects the energy transition to add as much as 25% in demand across the firm’s key products by 2035. On the ESG front, Rio is aiming to halve its emissions by 2030. It plans to invest around $7.5 billion globally to halve its total operations emissions by 2030, a clear commitment to achieve a more sustainable and environmental friendly business.

 

Precious Metals

Gold extended its advance after Federal Reserve Chair Jerome Powell signaled the pace of tightening would slow at the next meeting, ahead of economic data that could bear on the central bank’s future rate hikes. Powell was optimistic inflation could be contained without the US economy tipping into recession, but said borrowing costs would still need to keep rising and remain restrictive for some time. Monetary tightening has weighed on non-interest bearing gold throughout the year by pushing up bond yields and the dollar, though bets on a slowdown and China’s Covid loosening saw it rise 8% in November – but is still down 14% from a peak in March.

On the company side, Newmont, the largest gold producing company, hosted an analyst update where the company reiterated that it expects to reinvest around $2.5bn/year, comprised of $1-1.5bn sustaining capex, $0.8-1bn growth capex and the rest allocated to exploration. The company said they are reviewing the inputs to its dividend framework and will likely use a $1’700/oz gold price assumption. Also, the company is willing to use cash on the balance sheet to fund the dividend – since 2019, the company has paid-out around 60% of its free cash flow. Newmont is expected to achieve its 2022 guidance. In the PGM sector, Northam fires up South Africa platinum takeover battle with another bid for smaller Royal Bafokeng (RBPlat) – Northam already holds about 34.5% of RBPlat, with options to raise its stake to 37.8% after buying out the company’s largest shareholder a year ago. Rival Impala Platinum has acquired around 41% of RBPlat as it seeks control of low-cost mechanized assets that are essential to maintaining the profitability of its adjacent Rustenburg operations. For Northam CEO, purchasing RBPlat would help close the gap on the country’s top tier producers and notes that the offer is aligned with Northam’s growth strategy and presents a unique opportunity to acquire a controlling interest in a scarce, high quality ore body with established and well capitalized infrastructure. Before making its offer, Northam had tried to block Impala’s bid for RBPlat on antitrust grounds.